MODELLING RISK IN THE INTERWAR FOREIGN EXCHANGE MARKET

In: Scottish journal of political economy: the journal of the Scottish Economic Society, Band 37, Heft 3, S. 241-259

Abstract

THE PURPOSE OF THIS PAPER IS TO MODEL TIME-VARYING RISK PREMIA FOR FORWARD EXCHANGE RATES USING 1920S DATA. APPLIED IS THE METHODOLOGY OF DOMOWITZ AND HAKKIO, AND THEN OF WOLFF AND TAYLOR. THE REMAINDER OF THE PAPER IS SET OUT AS FOLLOWS. SECTION II DISCUSS THE RELATIONSHIP BETWEEN RISK PREMIA AND SPOT AND FORWARD RATES AND, IN PARTICULAR, SHOW HOW RISK-AVERSION ON THE PART OF FOREIGN EXCHANGE MARKET PARTICIPANTS MAY DRIVE A WEDGE BETWEEN FORWARD RATES AND EXPECTED FUTURE SPOT RATES. SECTIONS III AND IV DESCRIBE TWO ECONOMETRIC MODELS OF RISK PREMIA--THE 'GARCH' AND DYMIMIC MODELS RESPECTIVELY. SECTION V DESCRIBE THE DATA AND THE HISTORICAL BACKGROUND TO THE PERIOD OF ESTIMATION, WHILE OUR EMPIRICAL RESULTS ARE REPORTED IN SECTION VI. SECTION VII CONCLUDES.